Marco Polo, the famous thirteenth-century Venetian merchant, was one of the first Europeans to trade with China. Now imagine that, after a while, the Venetian state became concerned that Polo was purchasing too many silks and spices from China to sell at a profit in Europe. The “trade deficit” he was creating, the authorities worry, would deplete the stock of gold in Venice, while creating jobs for Chinese, rather than for Venetians.

In this imaginary history, Venice assembles a council of experts to decide whether the risks posed by the trade deficit merit retaliation in the form of tariffs, quotas, or potentially even a ban on trade with China. As the council deliberates, two competing theories emerge.

One group – the “mercantilists” – argue that it is up to the state to maximize gold holdings and protect domestic manufacturing employment, by imposing tariffs, restricting the use of gold for imports, and forcing China to buy the same amount of goods from Venice that Venice buys from China. If China refuses to do so, Polo’s purchases will have to be restricted.

The second group, led by Adamo Fabbro, subscribes to the laissez-faire argument that the state should avoid intervening in markets. By buying goods from China, Polo was promoting economic wellbeing in Venice: consumers benefited from goods they could not acquire domestically – at least not at such a low cost – and merchants were profiting by re-selling Chinese imports at a markup. While manufacturing jobs might be lost, retail jobs were gained, and spending – not just on Chinese goods, but also on local products and investments – rose.

As for the depletion of Venice’s stores of gold, Fabbro offers an ingenious solution: a paper currency, the Venetian dollar (V$), which other countries could be compelled to accept because Venice was the world’s top trading power. China would receive no more Venetian gold, and it could use the V$ to purchase goods from Venice, thereby boosting local manufacturing. In order to preserve the value – and thus the credibility – of the V$, Fabbro proposes establishing a central bank to manage the money supply, thereby preventing excessive inflation.

Venice’s leaders are convinced. They implement Fabbro’s recommendations, and, as he had predicted, Venice becomes the world’s leading power, thanks to burgeoning trade, rapid economic growth, and broad prosperity – all enabled by free markets.

One large Venetian merchant, Walmartius, is buying V$50 billion worth of Chinese goods each year to sell for profit locally, an endeavour that supports the creation of thousands of local retail jobs and lowers costs for Venetian consumers. Another merchant, Appleos, designs high-tech goods in Venice and manufactures them in China, enabling the company to achieve a market valuation of V$1 trillion.

Trade deficits do swell, but they cost Venice nothing because they are denominated in Venice’s own currency, in exchange for which other countries freely provide goods. In fact, before long, all international trade is conducted in V$, which is universally accepted as a surrogate for gold.

Thanks to the Venetian central bank’s reliable prevention of V$ depreciation, confidence in the currency continues to grow, creating a virtuous cycle. Soon, every country in the world purchases V$ bonds to hold in their foreign-exchange reserves, thereby effectively financing Venice’s large budget deficits. All of this enables Venice to fund large public programs and maintain the world’s largest military, deepening its international clout as it leads the way in enforcing global trade rules and securing sea lanes.

This happy state of affairs continues for a few centuries. Though lower-value-added jobs in sectors like manufacturing shift to China, where labour costs are lower, jobs in higher-value-added sectors – such as technology, finance, media, and retail – flourish. Venice remains the world’s largest economy and leading trade power, enjoying a secure position at the top of global value chains.

Sometimes in history, one can pinpoint the precise moment when things take a turn for the worse. In this story, that moment comes with the emergence of Donaldo Trumpi as the ruler of Venice.

Trumpi understands little about economics. He is more performer than a policymaker, eager to win votes however he can. He sees that a subset of Venetians are upset about the loss of manufacturing jobs – they lacked the skills or flexibility to move to higher-value-added sectors – and he capitalizes on it. He likens trade deficits to economic losses – almost to theft – and declares China the enemy.

Some of Trumpi’s advisers try to explain to him how trade deficits work in an economy that benefits enormously from having the world’s leading reserve currency. Challenging the trade deficit, they tell him, can imperil the V$’s reserve-currency status. Moreover, the Venetian deficit amounts to just 3.4% of Venice’s massive GDP. They explain that a return to mercantilism could spur others to do the same, potentially by creating an alternative reserve currency through a global institution. Only then would Venice’s trade deficits become a problem, they tell him. The government would be forced to reduce spending, including on the military, throwing the economy into recession and eroding Venice’s international influence.

But Trumpi refuses to listen. Centuries after mercantilism was abandoned in favour of highly successful laissez-faire policies, he decides to embrace it, imposing tariffs on Venice’s trade partners, beginning with China. And it ends about as well as his advisers thought it would.

Trumpi’s approach erodes the rules-based global economic order that had served the world – and Venice – so well. Eventually, the rest of the world reverts to mercantilist policies as well, imposing trade barriers and refusing to use the V$ for international trade. An institution the Venetians helped establish and once led, the International Monetary Fund, creates a new reserve currency, based on gold convertibility. Over the subsequent century, Venice watches helplessly as its economic and military power dwindles.

Unfortunately, this imaginary past is now threatening to become our real future. If it does, it will be a major turning point in world history – and all the more remarkable because, unlike most such shifts, there will be no doubt about where the blame lies.

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